ISLAMABAD (March 07 2003) : After facing serious adverse outcomes of the raising forex reserves, the government is altering its policy of external financial market by slowing pace of buying dollars for the interbank market.
The persistence of unexpectedly high private capital/remittances inflows is putting upward pressure on the exchange rate, posing a dilemma for monetary and exchange rate policy, says government in its letter of intent (LoI) to the International Monetary Fund (IMF) released on Thursday.
Lesser absorptive capacity in economy was unable to utilise the inflow of money coming from abroad and government's earlier fear to avoid shooting inflation led to sterilisation policy.
The LoI said continued massive sterilisation would entail a further compression of domestic credit as well as significant fiscal cost.
A modest appreciation against the US dollar should also help in avoiding a perception by the market that the SBP pursues an implicit peg.
This shift should contribute to slow the growth of broad money in coming months, even though the government has revised upward the broad money target for 2002/03, consistent with the much higher-then-expected NFA accumulated through end-2002.
The government remains alert to the danger that high broad money growth could eventually translate into higher inflation, and would, therefore, closely monitor inflation developments and prospects, and tighten monetary policy should show signs of emerging inflationary pressures.
The government believed that addressing these inflows, in case they persist, required somewhat greater exchange rate adjustment and a slowing of the pace of foreign exchange purchases in the interbank market aimed to build up foreign exchange reserves and contain a real appreciation that could adversely affect non-traditional exports.
In case of a reversal of the private capital flows which cannot be excluded if the regional/security environment were to deteriorate, allowing a market-based depreciation and financial tightening would be the first line of defence, with reserves used only to maintain orderly market conditions.
